Seven steps to financial fitness

If you're like many Americans, slimming down, shaping up, or eliminating bad habits may top your New Year's resolution list. But as many planners will tell you, the New Year is also a great opportunity to do things differently with your money. With that in mind, here are seven tips to increase the likelihood of a profitable 2005:

1. Start saving more. Sure, this sounds about as exciting as eating broccoli. But this year, Uncle Sam is sweetening the pot. By saving more for retirement, you can enjoy certain tax benefits. Limits on how much you can set aside in retirement accounts go up this year. For example, eligible taxpayers can now sock away $4,000 a year into individual retirement accounts - up from $3,000 in 2004 - or $4,500 if they're 50 or older by the end of the year. Keep in mind, there are two types of IRAs - a traditional IRA, which defers taxes, and a Roth, which is taxed immediately but grows tax-free.

You can also push more money into 401(k) retirement plans this year: $14,000, up from $13,000 in 2004. If you are 50 or older, you can contribute up to $4,000 more.

"You should definitely consider reducing your taxable income in 2005 by increasing the amount of pretax salary deferrals to your employer benefit plans," says Ric Edelman of Edelman Financial Services in Fairfax, Va. "This tax-free money is like giving yourself a raise."

2. Rethink real estate. If you rent, make 2005 the year to own. Buying a home can be one of the most positive and far-reaching financial decisions you will make. Not only are you building equity in an asset that typically increases in value, but you'll also reap a number of benefits and deductions at tax time. Mortgage interest rates remain near historic lows.

If you already own your home, but haven't taken advantage yet of low mortgage rates, make this one of your first priorities in the New Year. As long as your mortgage isn't almost paid off and you're not planning to move within the next two years, the move could save hundreds of dollars a month. But move fast. The Federal Reserve has hinted that more interest-rate hikes are in store for 2005.

"Refinancing a 30-year mortgage in which you're paying above 6.5 percent could save you a few hundred dollars per month," says Marc Freedman, a certified investment manager at TriCapital Advisors in North Bethesda, Md.

3. Trim that credit-card debt. Thanks to the "Santa Claus rally," it was a good year for investors as both the Dow and the Nasdaq reached levels not seen since before the Sept. 11 attacks. But high- interest credit-card debt can eat away at those portfolio gains. American households with at least one credit card carry an average unpaid balance of $8,940, according to CardWeb.com, a leading publisher of credit- and debit-card information.

"Credit-card debt is bad debt. So eliminating revolving credit should be the first order of business," says Gary Ambrose, a financial planner with Personal Capital Management in New York City. "Paying 18 or 19 percent on a credit card is like throwing away money. At the very least, try to consolidate your debt with a low- interest credit card."

Another possibility is to ask your creditors for a lower interest rate. Credit-card companies will often oblige, particularly if you mention that a competitor is offering you a lower rate.

If you decide to reduce your debt by sending in more than the minimum payments, first pay off the cards with the highest rate. Even better is to transfer the balance to a home-equity loan, Mr. Ambrose says. The rate will probably be lower than what you're currently paying and the interest is tax-deductible.

Consumer advocates also recommend checking your credit report once a year. One in four reports contains errors that cause consumers to be denied credit, a loan, or even an apartment or job, according to a 2004 study by the US Public Interest Research Group.

"Not only do you want to see that the credit-card companies have noted that you've paid off debt or closed accounts, you also want to check for identity theft," says Joel Ticknor, a certified financial planner in Reston, Va. "The idea behind a credit report is to put yourself in an improved position for the next time you borrow money."

For a free credit report, contact any of the three credit-reporting agencies: Equifax (www.equifax.com), Experian (www.experian.com), or Trans-Union (www.transunion.com).

4. Reevaluate your portfolio. One of the biggest mistakes you can make is to keep holding on to a losing investment. "The beginning of the year is a very good time to take a good, hard look at your portfolio," says Mark Kaizerman, a certified financial planner in Natick, Mass. "If an investment doesn't feel right, get out of it."

Holding on to winners too long is also a mistake. That's why it's a good idea to have a sell discipline in place - for winners and losers. "People need to remember: You can never exactly time the market - either at the top or the bottom," says Mr. Edelman.

Many financial planners say you should also use the New Year to look at your allocation for your 401(k). "It's a very good time to consider investing in international stocks or funds," says Dixie Butler, a certified financial planner in McLean, Va. "This type of investment - balanced with your other investments - actually decreases risk."

5. Update your insurance and will. It may sound like a pitch from an overzealous insurance agent, but most people are underinsured. Just ask Florida homeowners who didn't check their insurance until after one of the busiest hurricane seasons on record.

"Many homeowners have not increased the value of their homeowner's policy - taking into account the rising value of their homes," says Mr. Ticknor. "With home values rising steadily, chances are they are not prepared should something catastrophic happen to their home."

When updating a home policy, consider the replacement cost of objects and increasing the deductible. Increasing the deductible from $250 to $1,000 can save hundreds of dollars in annual premiums.

Reevaluate your life insurance, too. You may be underinsured if your net worth has risen substantially.

"Make certain you have the correct beneficiary information on all of your policies," says Mr. Kaizerman. "People sometimes forget to update their policies in the event of a divorce, a remarriage, or an untimely death in the family."

Finally, if you don't have a will yet, get one. And if you already have one, make certain to review these documents. Identify items that are incomplete, outdated, incorrect, or missing. Start now to fill in those blanks.

In addition, a surviving spouse needs to know many things, such as the location of the will and when it was last updated.

6. Stick to a budget. The key is to separate your required needs (rent or mortgage, utilities, insurance, food, and clothing) from discretionary desires (entertainment, cable TV, and eating out). Then try to direct at least 4 to 5 percent of your income to savings and investments.

"Budgeting and making spending priorities are important goals regardless of your income level," says Mr. Freedman.

7. Develop an emergency fund. Many people think "it won't happen to me." But you never know when an emergency can strike. For that reason, consider setting aside money to cover a financial emergency such as the loss of a job.

"Try to set aside six months for living expenses," says Ms. Butler. "Treat the emergency fund as a monthly bill you must pay and put it in a fairly liquid vehicle, such as a savings or money-market account."

Having an emergency fund can give you great peace of mind and is a smart alternative to using a credit card to help cover a major expense.

"If you develop an understanding of your income and expenses, then socking money away for a rainy day won't be that difficult," says Kaizerman. "Of course, meeting with a financial adviser is always a good idea to determine how much money to put into an emergency fund and how much to invest."

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